OTTAWA, Feb 22 Canada's economy registered its
lowest inflation in more than three years in January and the
largest decline in retail sales in almost three years in
December, a double whammy that weakened the currency and
darkened the country's growth outlook.

Friday's Statistics Canada reports prompted several
economists to water down forecasts for December and
fourth-quarter gross domestic product data, which is due March 1
.

They also pushed out expectations for the next Bank of
Canada interest rate increase and raised the possibility that
the central bank could tone down its policy-tightening language
further than it has already in the past few months.

"This combination of data just piles on what had already
been a weak footing for the Canadian dollar," BMO Capital
Markets chief economist Doug Porter said. "Both numbers came in
below already weak expectations. Obviously the real eye-opener
here was the retail sales result."

The Canadian dollar softened to its weakest level
in nearly eight months on the data, touching C$1.0256 versus the
U.S. dollar, or 97.50 U.S. cents.

DAMPENS RATE HIKE TALK

Statistics Canada said lower gas prices helped push the
annual inflation rate down to 0.5 percent in January from 0.8
percent in December, the lowest level since the 0.1 percent
recorded in October 2009.

The annual rate was less than the 0.7 percent forecast by
market analysts and further outside the Bank of Canada's target
range of 1 to 3 percent, offering more evidence that the central
bank is under no pressure to raise interest rates.

"All of this would feed into a dovish Bank of Canada and
Canadian dollar weakness," said Camilla Sutton, chief currency
strategist at Scotiabank.

The Bank of Canada's closely watched core inflation rate,
which excludes the prices of items such as energy, tobacco and
some food, slipped to 1.0 percent from 1.1 percent in December.

Sutton also noted with concern that on a seasonally adjusted
basis, prices fell 0.1 percent in January from December.

The 2.1 percent fall in seasonally adjusted retail sales in
December from November was far larger than the 0.3 percent
decline predicted by market operators and suggested already
muted expectations for fourth quarter growth might be too
optimistic.

The monthly fall in retail sales was the greatest since the
2.4 percent decline recorded in April 2010. Trade was pulled
down by slumping new car sales and a weak Christmas shopping
season, though some of this was because some purchases were
advanced to Black Friday in November. Year on year, sales were
down 0.7 percent, the worst performance since October 2009.

GROWTH FORECASTS CUT

Last month the Bank of Canada cut its fourth-quarter growth
forecast from an annualized 2.5 percent to 1.0 percent. But most
forecasters say even that is too optimistic. The median forecast
in a Reuters poll is 0.6 percent in the fourth quarter.

The consensus is that GDP will contract in December, weighed
down by declines in manufacturing, wholesale and retail trade.

In volume terms, used for calculating real GDP moves, retail
sales fell 1.6 percent in December from November.

Sales by auto and parts dealers dropped by 6.4 percent
Sales at electronics and appliance stores, which jumped in
November as Apple rolled out its iPad mini, fell by 12.1
percent.

BMO's Porter said he had been looking for a decline in
retail sales, but nothing on the order of the actual fall. "And
of course December just happens to be the most important month
of the year for retailers. So obviously what had been a so-so
year for retailers ended with a thud in December."

Overnight index swaps, which trade based on expectations for
the central bank's key policy rate, showed that after the data
traders eliminated already small bets on a rate increase in late
2013.

The Bank of Canada insists that its next rate move is likely
to be up, but has said that an increase is not as imminent as it
had once thought.

Further guidance may come on Monday from a speech and news
conference by bank Governor Mark Carney.

Adding to the economic slowdown is a cooling of Canada's
housing market. The federal housing agency on Friday said it
expected housing starts of 178,600 to 202,000 this year, down
from 214,827 in 2012.

Next In Bonds News

WASHINGTON, Dec 9 The U.S. Senate passed
legislation on Friday to fund the government through April and
sent it to President Barack Obama for signing into law, after
Democrats who sought more generous healthcare benefits for coal
miners stopped delaying action on the measure.

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